Asset Class Liquidity Risk

This paper studies liquidity risk, as measured by the covariation of returns with unexpected changes in aggregate liquidity, across 106 indices covering global equity, industry sectors, fixed income, and hedge funds. Roughly 20% of all sample indices, and over 50% of hedge-fund indices, display a significant exposure to liquidity risk. The annualized cross-sectional liquidity risk premium is estimated at about 2%. The results are robust to various controls and methodological choices. Practical implications for risk management and asset allocation are discussed. Investors with relatively short investment horizons may find it useful to hedge liquidity risk by acquiring low-liquidity-beta assets, while long-run investors may consider increasing liquidity-risk exposures to earn the associated risk premium.
Keywords: Global Equity; Fixed Income; Hedge Funds; Liquidity Risk; Asset Allocation; Risk Management.
JEL codes: G12; G14; G23.